The U.S. dollar (USD) entered a cyclical downturn in 2025, marking what we believe is the start of a multi-year bear cycle. As we discussed in our Long-Term Capital Market Assumptions (LTCMAs), for a few years now, the dollar has been overvalued and vulnerable to a regime shift. Last year’s policy uncertainty provided a catalyst for the beginning of a new cycle. Despite a 10% decline in the U.S. Dollar Index in the first half of 2025 and the currency’s subsequent stabilization, we believe macro and market fundamentals will drive further dollar devaluation. If history is any guide, this downtrend will persist for several years, creating important opportunities — and portfolio construction considerations — for investors.

In this report, we review recent developments in the dollar, consider the fundamental forces that inform our view, and weigh the multi-asset implications of a weakening U.S. dollar.

A cyclical dollar downtrend, which can be played across asset classes, bolsters our conviction in the tactical tilts we take in our multi-asset portfolios. Dollar weakness supports the case for greater international equity exposure for USD-based investors, improves fundamental conditions across emerging markets by easing dollar-based financing pressures, and strengthens the medium-term outlook for gold. By expressing the weak dollar theme across multiple asset classes, investors can benefit from the dollar bear cycle in a more diversified and less correlated way, rather than relying solely on a set of higher-risk, standalone currency trades.

Market divergence and policy uncertainty expressed through FX

Over the past two years, foreign exchange markets have increasingly acted as the release valve for U.S. policy uncertainty. This dynamic became particularly salient around last April’s “Liberation Day.” President Trump’s reciprocal tariff announcement triggered a “triple sell-off” reminiscent of past emerging market episodes — with U.S. equities, bonds and the dollar all falling simultaneously.

In the wake of that shock, U.S. stocks and bonds recovered in the months that followed. The S&P 500 retracted its severe drop in just a month, and the 10-year U.S. Treasury yield returned to its pre-Liberation Day level less than five months later. But the dollar never recovered. (Exhibit 1).

That divergence in market performance is instructive. Foreign investors remained eager to hold U.S. assets — particularly equities linked to structural growth themes such as artificial intelligence — but they increasingly hedged their exposure to the dollar. In other words, investors liked corporate America even as they hedged the risk of official America.

Similar divergences have occurred several times over the past year and a half and we think the trend could persist as ongoing policy uncertainty drives further weakness in the U.S. currency. Most recently, the U.S. Dollar Index declined over 3% in just a week following President Trump’s threats to invade Greenland. The greenback has not retraced its fall, despite a full recovery in U.S. equities. 

Shifting fundamentals on rates and growth driving our U.S. dollar outlook

Several powerful forces suggest that the dollar has entered a cyclical downturn that will continue in the coming years.

The first and perhaps most important factor: The fundamentals are shifting as rate and growth differentials narrow, in part due to fiscal convergence.

U.S. economic outperformance – often referred to by investors as “U.S. exceptionalism” – underpinned the dollar’s strength in recent years. So too did the carry on offer from the U.S. dollar, which was more attractive compared with carry in other countries. Since the global financial crisis, the differential between U.S. and global growth has consistently narrowed (Exhibit 2). U.S. real GDP growth has ranked first among the G7 advanced economies for most of the past decade. 

In our view, that dominance will likely begin to diminish. While we still expect that U.S. growth this year will come in above the 1.8% trend rate that we forecast in our 2026 LTCMAs, we believe that the differential will compress as the euro area, Japan and China deliver growth above consensus expectations.

This shift will partly reflect fiscal policy changes. Several G10 countries are emerging from extended periods of fiscal restraint and now plan significant deficit-financed public investment and defense spending. As fiscal policy becomes less asymmetric across regions, one of the dollar’s key structural tailwinds will abate.

At the same time, we expect continued — albeit gradual — policy rate convergence. The Federal Reserve (Fed) is still in an easing cycle, with another rate cut expected by June or July. The European Central Bank (ECB) will likely remain on hold. Meanwhile the Bank of Japan (BoJ) will continue to raise rates, especially as Prime Minister Takaichi’s recent landslide win in early February will likely bring about stronger than expected economic growth. In the wake of the election result, we have brought forward our forecast for the next BoJ rate hike to April 2026.

We see a clear impact of this global policy convergence: The carry advantage embedded in the dollar is eroding. In our view, the trend will likely continue over the next couple of years (Exhibit 3).

Shifting capital flows and portfolio rebalancing

We turn now to the second force propelling a weakening dollar cycle: global capital flows. In recent years these have been heavily skewed toward the U.S., leaving the dollar vulnerable to rebalancing and hedging.

International investors are significantly overweight U.S. assets following years of U.S. economic and market outperformance. According to U.S. government data, the U.S. net international investment position has deteriorated from around USD 2 trillion in 2010 to over 27 trillion in 2025.

Concentration in U.S. assets increases the sensitivity of the dollar to even modest portfolio rebalancing, diversification, or changes in hedge ratios. Given the concentration in U.S. assets, portfolio rebalancing is overdue for most investors. It may be accelerated, on the margin, by political tensions between the U.S. and other nations.

Rebalancing may have far-reaching effects across asset classes and markets. Recent episodes — including sharp appreciation in currencies such as the Swiss franc earlier this year — illustrate how marginal repatriation flows can generate outsized FX effects on smaller local currency markets.

As correlations between the dollar and risk assets have risen (Exhibit 4), FX hedging is no longer a residual decision in portfolio construction for many investors; instead it is a more central portfolio choice, putting greater downward pressure on the dollar.

That portfolio choice becomes more attractive as hedging costs have declined alongside the Fed easing cycle. In several regions – notably Denmark – we note a rapid and coordinated move to raise hedge ratios on U.S. assets. Danish pension funds and insurance companies have led the way, with aggregate USD asset hedge ratios (across both equities and bonds) rising from around 60% to over 70% over the course of 2025.

Similarly, in Australia, institutional pension funds have begun actively increasing their hedge ratios on U.S. assets after allowing them to drift lower in recent years. According to industry data, Australian superannuation funds have raised their average FX hedge ratios by several percentage points since late 2024, reversing a multi-year trend of declining hedging. This move creates a structural headwind for the dollar, even in the absence of significant selling of U.S. stocks or bonds by central banks or private investors. The data shows no evidence of large-scale selling, despite persistent media headlines to the contrary.

Looking forward, we think elevated dollar hedging will at least persist and potentially increase given the weakening cyclical profile of the currency and declining hedging costs.

Long dollar cycles

The third force spurring a bear cycle for the dollar is a long-observed fact of currency markets: Dollar cycles are long.

Historically, full dollar cycles have lasted 15–20 years — far longer than a typical business or equity cycle. The last full cycle spanned more than two decades, from the dot-com bust (USD peak around 2001-2002) through to the post-global financial crisis and euro area debt crisis era (trough around 2008-2011) to the start of the Trump administration (a peak around the start of 2025). Given the relatively recent peak in dollar strength, history suggests that the current adjustment still has considerable room to run (Exhibit 5).

Finally, even as the dollar weakens, we believe that it will retain its reserve currency status and indispensable role in global financial markets.

Despite rising correlations between the dollar and risk assets, we do not view the weakening of the currency as a genuine challenge to the dollar’s reserve currency status. Instead, USD weakening should be understood primarily as a cyclical repricing of the dollar from exceptional levels. The repricing reflects the forces we have discussed: narrowing rate and growth differentials, evolving capital flows and elevated economic and geopolitical uncertainty.

While alternative currencies and payment systems may begin to present certain long-term challenges to the dollar, the U.S. currency remains dominant across foreign exchange reserves, trade invoicing, international payments and global funding markets, (Exhibit 6). We expect dollar dominance to continue, in part because no other currency stands ready to take its place.

Despite the Trump Administration’s reported preference for a weak dollar, actual U.S. government intervention in currency markets is rare. In our view, significant currency intervention by the current U.S. Administration is highly unlikely absent a crisis. We believe that “rate checks,” like the one completed in January during the episode of yen volatility, will be used sparingly. In a rate check, the government asks dealers about market pricing. These checks can precede direct government intervention in currency markets. But there is a high bar to move from a rate check to actual intervention.

We think the U.S. government will remain primarily focused on maintaining the dollar’s role as the world’s leading reserve currency – not targeting specific USD price levels – as well as preventing disorderly moves, and utilizing U.S. macroeconomic, regulatory, trade and energy policies to attract capital inflows.

What could challenge our view?

A potential risk to our outlook lies in a movement along the well-known “dollar smile.” Under this theory, the dollar tends to strengthen in two extreme economic scenarios: acute global recession or exceptionally strong U.S. growth. These represent the edges of the smile. The dollar weakens when U.S. and global growth differentials narrow – representing the center of the smile. Exhibit 7 shows the dollar smile in action in the 2020–2021 period. The dollar strengthened during the acute phase of the COVID crisis and the strong U.S. GDP rebound in 2021, but weakened during a period of more tepid growth in between. 

However, as we have discussed, today’s heavy capital concentration in U.S. assets means that investors could undertake a significant repatriation of assets back to their home countries in the event of a U.S. recession, leading to a weaker dollar. This prospect has led some to postulate the emergence of a “dollar smirk,” where the dollar does not rally as much as expected in the event of an economic downturn, especially one concentrated in the U.S. 

Uncertainty in U.S. policy has contributed to rising dollar correlations with risk assets. Policy uncertainty also plays a role in gold’s remarkable outperformance in recent years, indicating that investors may be looking to bolster their store of safe assets. Notably, gold has been hitting all-time highs every year since 2022. Meanwhile the dollar has recently failed to rally as strongly as it did in past risk-off episodes, underscoring the evolving dynamic of currency and risk asset pricing.

The dollar now appears to be trading in the middle of the smile, where moderating growth differentials between the U.S. and the rest of world weigh on the currency. A sharp departure from this macro environment could alter the currency’s trajectory. A major productivity shock that significantly raised potential GDP – such as a broad-based and rapid payoff from AI – could reestablish U.S. exceptionalism and support the dollar. Some data suggest emerging signs of slightly higher productivity payoff from AI, along with a more rapid pace of AI adoption as compared to previous major technologies. Still, we believe it will take years, not months, to see significant economy-wide AI-driven productivity gains.

The opposite scenario, a severe global recession, seems unlikely. While we continue to monitor the risk of a mild recession should the U.S. labor market deteriorate quickly, bottoms-up signals from companies and our proprietary Chase data – which tend to be leading indicators – suggest that the economy remains in a relatively healthy late-cycle phase. Exhibit 8 presents a graphic representation of our quantitative U.S. business cycle tracking model, which projects the probability that the economy is in each stage of the cycle. It now shows that the economy is likely in late cycle.

Implications for multi-asset investors

Multi-asset investors are uniquely able to express a weaker dollar view across a broad set of asset classes rather than relying on FX exposure alone. In our portfolios, our dollar outlook reinforces several existing convictions. In some cases, a weak dollar mechanically boosts returns. In other cases, a weaker dollar view shares the same fundamental drivers as other portfolio convictions.

Here are our key views as we position our multi-asset portfolios:

• Long euro-dollar (EUR-USD): We hold medium conviction in EUR-USD appreciation over the next 18 months, supported by narrowing growth and rate differentials and improving European fiscal dynamics. This includes Germany’s loosening of the debt brake and an ambitious fiscal spending plan. Our long-term terminal spot estimate for EUR-USD is 1.26, though we expect the currency to frequently overshoot fair value during extended cycles, increasing our expected return from this trade.
• Long globally diversified basket of stocks, with an international tilt to emerging markets: We overweight global equities on the back of above-trend growth, global fiscal stimulus and a resilient AI ecosystem. In the face of full valuations, we prefer a globally diversified portfolio with a modest international tilt toward emerging markets, which offer greater exposure to AI-linked themes. A weaker dollar provides an additional tailwind to this view by boosting unhedged foreign equity returns for U.S.-based investors. More broadly, easing dollar pressure supports companies with USD-based financing and benefits EM regions that are heavily dependent on commodities. During the last weak dollar cycle in 2002–07, MSCI Emerging Market Index levels roughly quadrupled.
• Emerging market sovereign debt (hard currency): Dollar weakness helps to ease the real burden of dollar-denominated liabilities, improving balance sheets for EM sovereigns and enabling investors to buy more debt. While we do not expect significant spread compression from current levels, we continue to view EM debt as attractive from an all-in yield perspective, bolstered by this fundamental tailwind.
• Gold: We have a positive outlook on gold over the medium term and see it as a long-term strategic diversifier in a multi-asset portfolio. For a strategic asset allocation, gold is generally additive under most reasonable assumptions (when sized correctly). In the current regime, gold also stands to benefit directly from dollar weakness. Because gold is priced in U.S. dollars, a weaker dollar tends to stimulate foreign demand and place upward pressure on prices.

Moreover, the same forces weighing on the dollar — such as lower U.S. real yields and elevated policy uncertainty — are supportive of gold. Despite the recent volatility, we note that gold still has a near-zero correlation with the S&P 500 over a one-year period and thus serves as a key diversifier.

Conclusion

The dollar is normalizing after an extended period of U.S. economic exceptionalism. The currency’s indispensable global role remains intact but it is likely entering a new bear cycle. For multi-asset investors, this presents an opportunity. Across FX, equities, fixed income and real assets, investors can implement a weak dollar theme, potentially strengthening portfolio diversification and creating durable value. 

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